LeoGlossary: Quantitative Tightening (QT)

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This is the opposite of Quantitative Easing (QE).

Quantitative Tightening is an non-conventional monetary policy where the central bank seeks tighten economic conditions. This is done through the combination of raising interest rates along with unloading assets from its balance sheet.

Due QE, the central bank swaps out central bank money for securities. In the United States, this is relegated mainly to Treasury and Mortgage Backed Securities. The idea is to provide more money to the real economy, thus fostering economic growth. Since central banks cannot do this under the fractional reserve banking system, it has to stimulate by getting commercial banks to make loans.

The swapping of central bank money for assets comes with the idea that commercial bank lending ceilings are increased through this action. If banks start lending, the money supply is expanded.

Ways Of Implementing QT

Central Banks have two options when it comes to their balance sheet. When the decision is to use a tighter monetary policy, the unwinding takes place.

Here are the two actions the Central Bank takes:

  • Reverse Quantitative Easing - here the securities are returned to the commercial bank and the reserve (central bank liability) is removed. In short, the swap is simply reverse.

  • Run-Off - here the security is allows to reach maturity and be redeemed. This means getting paid in the currency (USD, EURO, YEN) and forwarding that to the commercial bank. Again the liability on the balance sheet is eliminated.

When the central bank engages in QT, the monetary base contracts, removing liquidity of central bank money.

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